When the Finance Act, 2024 rewired the tax treatment of share buybacks, it upended a long-standing system that had—with all its imperfections—at least been predictable. Starting Oct 1, 2024, the burden of tax shifted decisively from the company to the shareholder.What appeared to be a simplification has instead triggered a chorus of concerns from tax experts, industry bodies, and investors—who warn that the new regime taxes notional income, creates economic distortions, and deviates from global best practice.In 2025, some listed companies did undertake the buyback route, notable being Infosys, Bajaj Consumer Care, Tracxn Technologies, SIS, Infobeans Technologies, Dhampur Sugar Mills.From Capital Gains to Dividend Tax: A Radical ShiftUnder the earlier system, listed companies undertaking buybacks paid buyback tax under section 115QA, while shareholders received proceeds tax-free.The 2024 amendment scrapped this and introduced a two-part mechanism for taxing shareholders:
- The entire buyback consideration is taxed as “deemed dividend” under section 2(22)(f).
- The original cost of the shares becomes a capital loss under section 46A. It is to be adjusted against other capital gains either in the same financial year or as set-off over the subsequent eight years,
For high-income taxpayers, buyback proceeds may now be taxed at slab rates up to 35.88%, despite the fact that the shareholder is surrendering and extinguishing their rights in the shares. That, experts argue, is the very definition of a capital transaction—not dividend income.The capital loss would be treated as long-term or short-term depending on the duration of holding of the shares before buy back. Listed shares that are held for more than a year (two years for unlisted shares) are treated as a long-term asset, with a tax rate of 12.5%. If in a subsequent sale in the open market of the remaining shares held by the investor or any other assets, the shareholder incurs a long-term capital gain, then the capital loss on buy-back can be set off. The impact is that the buy-back proceeds are at first taxed as dividend as per the slab rate (which for many investors will be higher than the long-term capital gains tax rate). Secondly, on sale of the assets, the loss (on buy-back) would be available for set off only against capital gains, which are taxable at a lower rate. Furthermore, if such loss has to be carried forward to future year/s, the return of income for the year of loss has to be filed on time; else, such loss is forfeited.Tax implications in the hands of a shareholder:
The Real-World Impact: A Tax Trap for InvestorsThe circularity becomes clearer when seen numerically. Under the new regime:
- Buyback consideration → taxed as dividend
- Cost of acquisition → treated as capital loss
- Capital loss → usable only against current or future capital gains, often at much lower tax rates and subject to timely return filing
Which means taxpayers pay high tax today and receive relief only later—and only if they have gains to offset. Countries such as Australia and the UK tax buybacks as dividends only to the extent of the income component embedded in the buyback price.The Anomaly: Taxing Capital as IncomeA buyback is not always funded by accumulated profits. Companies may buy back shares using:
- retained earnings,
- share premium, or
- proceeds from a fresh issue.
In the latter two cases, there is no distribution of profits at all. Yet, the entire payout is treated as dividend income in the shareholder’s hands. As Ravikant Kamath, partner at EY-India points out, this results in artificial taxation of a capital receipt.He illustrates: A loss-making company using its share premium to carry out a buyback at Rs. 20 each, against a face value of Rs. 100 each, it triggers dividend taxation—even where the shareholder suffers an economic loss.In the light of the upcoming Budget 2026, Ravikanth Kamath, recommends various alternative mechanisms that can be introduced for taxing buyback of shares.1. Restore capital gains treatment under section 46ATax should be levied only on the difference between buyback price and cost of acquisition, as originally designed since 1999. There are sufficient guardrails in both Companies Act and Income tax Act to prevent abuse of disguised dividends.2. Do not tax buybacks funded out of share premium or fresh issue proceedsThese are capital transactions, not profit distributions.3. For buybacks out of retained earnings, split taxation appropriately where only the amount representing accumulated profit is treated as dividend.
- Amount representing accumulated profits →dividend
- Amount representing capital returned → capital gains, not taxable as dividend.
